While the best practices of personal finance remain constant, the mechanics of banking, investing, borrowing, and decision making have made a massive leap forward. Technology enables these improvements. Brokerage fees have gone to zero. Mutual fund fees have declined sharply. Online tools facilitate all aspects of personal financial management, from banking to retirement planning. What’s more, an individual or family can manage the entirety of their finances from a smart phone, from finding the best mortgage rate to researching investment products. It is worth reflecting on these remarkable changes and what they suggest for the future.
The improvements in personal finance may be broken into five areas:
- Reduced costs
- Broader access
- Increased transparency
- Improved tools
- Online community
Each of these can be of substantial value and we are seeing continuous enhancements to financial services and related technology. While these positive changes can improve lives, there remain some barriers to reaping these benefits.
The reduction in costs in almost every financial service is remarkable. Most recently, brokerage commissions have fallen to zero, but this is actually one of the least significant cost reductions for most households. Probably the most important is the dramatic decrease in costs associated with mutual funds and, more recently, exchange traded funds (ETFs). The asset-weighted expense ratio of stock mutual funds in the U.S. has fallen from 0.99% in 2000 to 0.52% in 2019. The asset-weighted expense ratio for stock ETFs is a mere 0.18% in 2019. There are a range of broad index funds with expense ratios lower than 0.1% per year. Over a working lifetime, a 1% expense ratio can reduce your total wealth accumulation by 30%. This type of estimate depends on a range of assumptions, but its a reasonable baseline for discussion.
Even though lower-cost products may be available, many individuals are unaware of how much they are currently paying for financial services and what the alternatives cost. A certain level of financial literacy is required to enable informed choices.
Access to basic financial services is far from universal, even in the U.S., but technology can dramatically improve things. People who don’t have access to mainstream financial services tend to pay higher costs because they use alternative providers such as payday lenders. Online banks can operate at reduced costs, potentially without physical bank branches at all. Falling overhead allows expansion of access to traditional financial services for more people.
Digital financial services are critical for serving people who simply don’t have a bank branch nearby. An increasing number of rural areas have few physical bank branches. In many poorer countries, digital tools provide access to banking services for the first time. Just as many of these nations skipped landlines and jumped straight to cellular service, they are leapfrogging brick-and-mortar financial institutions.
Increased access to financial services via digital channels is incredibly significant, not least because digital services tend also to be cheaper than those that they replace. Higher access, coupled with lower costs, enables economies of scale and thereby reduces costs even further.
Anyone with internet access can quickly find the lowest rates on mortgages and other loans, the highest rates on savings accounts and CDs, and cost comparisons across providers of the entire gamut of financial services (annuities, insurance, etc.). Services such as Credit Karma allow people to monitor and track their credit scores at no cost, as well as identifying potentially better financial products based on a user’s credit scores.
Many, if not most, people don’t know how to answer the most important questions about financial planning. The biggest question is simply how much to save towards retirement and how much they need to reach in total assets to be ready to retire. Closely related is how to allocate these savings. Providing this type of information requires a range of inputs, along with some relatively involved calculations. In the last twenty years, and especially over the last decade, a range of well-designed online tools have been developed to help with these questions and many of these are free. There are also calculators that can figure out whether its worth refinancing a mortgage or making any of a number of other choices.
The available online tools will continue to improve. One challenge, of course, is how potential users will be able to find the most credible offerings.
Prior to the launch of online forums and related platforms, it was often hard to find people with whom to discuss financial planning. In many social circles, discussions of money and wealth remain taboo. This is unfortunate because figuring out how to make major financial decisions is hard and, often, misinformation abounds. Today, there are a number of well-established online discussion forums with communities that can provide useful education and discussion of financial topics. One of my personal favorites for the broadest range of topics is Bogleheads’ Forum, but there are many others that offer different perspectives and/or cater to targeted interests and needs. The rapid growth of the financial independence movement, for example, is powered largely by online community.
Having a community, typically anonymous, with whom to discuss the challenges of personal finance is incredibly valuable, especially since many people never have any formal financial education. Over time, these online communities build trust among their participants and collaboratively create valuable libraries of information as well as providing real-time discussion.
The Road Ahead
Today, it is possible to build and maintain a portfolio of financial products and services for a fraction of the costs faced by previous generations. Not only have costs fallen, but people can easily find the best deals for the products and services they seek. In addition, there are excellent communities that provide discussion and contrasting perspectives on every aspect of personal finance. Technology is in the process of completely demolishing the need for brick-and-mortar financial services. This process lowers costs and increases access.
The major challenge in leveraging technology for financial services is to increase financial inclusion, making sure that under-served communities also enjoy the benefits. The first part of increased inclusion is technological, providing more people with devices and connectivity. The second element is to educate people as to the availability and appropriate use of all of these tools, products, and services. Financial literacy remains a huge stumbling block in the United States and beyond.
In summary, we are building remarkable infrastructure to assist people in financial planning and the investment options available are getting more intelligent, cheaper, or both. The open question is how the masses of potential users will be guided to adopting better tools and how they will learn to distinguish between the aggressive marketing pitches and what is in their own best interests. A related challenge is in applying the principles of behavioral finance through software to facilitate better decisions. If we are not trained and conditioned to resist the endless temptations of consumerism, improvements in financial services will be of limited value.